By Tiernan Ray

Shares of Internet radio purveyors Pandora Media (P) today rose 55 cents, or 3%, to close at $18.95, and hit as high as $20.29, after Morgan Stanley‘s Scott Devitt raised his rating on the shares to Overweight from equal Weight, characterizing it as the “The Netflix (NFLX) of Radio: a truly disruptive form of content consumption that offers investors the best pureplay exposure to the secular shift of broadcast radio dollars to online channels.”

Devitt raised his estimates slightly for this year to reflect higher subscriber count but a cap on the individual listening hours of subscribers:

Pandora’s listener hours in May indicated that the 40-hour monthly cap on mobile users is having a larger impact than we first anticipated. We lower FQ2 listener hours (to 4.1B from 4.4B) and divert more hours to the subscriber bucket as we believe conversion rates continue to benefit from both the cap and the decreased friction of mobile billing channels in general. The lower listener hours we are modeling have a minimal negative impact on near-term ad revenue (as Pandora has plenty of inventory to sell), and this is more than offset by the uptick in subscribers. Our F2014E adj. EBITDA forecast rises by ~$6MM to $26MM (+33%) due to lower content costs from lighter listener hours on essentially the same revenue base.

Devitt’s view for this year is now $652.1 million in revenue, both advertising and subscription combined, and 7 cents EPS. That compares to a prior view for $652 million and 4 cents. His 2015 view goes to $938.3 million and 35 cents EPS from a prior $927.7 million and 24 cents. Street consensus is at $632.2 million and 4 cents this year and $873.5 million and 26 cents next year.

In Devitt’s view, Pandora has overcome “gating factors” that had prevented it from “gaining meaningful share” in broadcast radio ad buying, including not having a large enough audience, not using the same metrics as ad buyers in radio do, not being integrated with “demand-side platforms” buyers use, and not facilitating sophisticated ad-buying campaigns.

But with Pandora notching up 4.3 billion user listener hours in Q1 of this year, just behind Google (GOOG) and Facebook (FB) in usage, he thinks the runway is clear for the company to dominate advertising spend in the medium:

With these gating factors removed, we believe Pandora’s audio ad revenue may accelerate if traditional radio buyers become comfortable buying digital audiences. If Pandora is able to maintain the dominant position in US digital audio consumption that it enjoys today, we believe it could be the biggest beneficiary of broadcast dollars shifting online. As we have seen with the dominant players in other forms of digital advertising, like Google (search) and Facebook (display), the market leader in a given category usually over-indexes in spend relative to usage, since smaller players usually monetize less efficiently. This leads us to believe that there is a real possibility that Pandora could capture broadcast radio spend proportionate to its share of radio, which would yield not only substantial upside to our base case revenue estimates, but also significant upside to our bull case revenue forecasts.

And the Apple (AAPL) factor? He thinks it’s more likley that the recently introduced iTunes Radio actually speeds up use of “streaming services,” perhaps benefitting Pandora:

With these gating factors removed, we believe Pandora’s audio ad revenue may accelerate if traditional radio buyers become comfortable buying digital audiences. If Pandora is able to maintain the dominant position in US digital audio consumption that it enjoys today, we believe it could be the biggest beneficiary of broadcast dollars shifting online. As we have seen with the dominant players in other forms of digital advertising, like Google (search) and Facebook (display), the market leader in a given category usually over-indexes in spend relative to usage, since smaller players usually monetize less efficiently. This leads us to believe that there is a real possibility that Pandora could capture broadcast radio spend proportionate to its share of radio, which would yield not only substantial upside to our base case revenue estimates, but also significant upside to our bull case revenue forecasts.

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There are 3 comments

JULY 1, 2013 4:56 P.M.

Anonymous wrote:

Pandora has about 1 million songs in its library. iTunes has 27 million. And he thinks people will stick with the music service that has 1/27th the music of the competition, which also happens to have 500 million accounts?

if a netflix competitor came out and offered 27 times more movies for the same price, there would be a stampede for that service.

JULY 1, 2013 5:00 P.M.

Gavin wrote:

Watch out investors it's a trap iTunes radio will tromp Pandora in the next two quarters after its launch!

JULY 1, 2013 11:18 P.M.

TheSluce wrote:

I was actually a Pandora shareholder and after watching the WWDC and Apple's presentation on iTunes Radio I actually sold my shares. It put enough uncertainty in Pandora's future to warrant a sell, particularly at their valuation. Plus, with Apple agreeing to what is assumed to be pretty generous royalty terms this should keep Pandora's costs high. Plus, with iTunes Match and the iOS car integration I see Apple being a force here. I love Pandora but their shares are just too expensive with the changing landscape.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.